10 Things Every Landlord Needs to Know About Commercial Lease Agreements
Commercial lease agreements between property owners and the tenants is the most important aspect that will dictate the dynamic between the parties. The vast majority of landlords and tenants focus on the term/rent, and resort to boilerplate leases provided by commercial brokers. But it is the other parts of the lease that often result in nasty disputes, like assignment clauses. We want to focus on 10 important items you should pay attention to when signing your next commercial tenant – and why an attorney can help you create more value getting you there.
Brokers provide a valuable service to landlords, but it’s always important to have an impartial lawyer review the lease terms.Sinai Law
Almost all Disputes can be Avoided with a Strong Lease (almost)
Almost 100% of clients who come to us after a dispute started with their tenant did not have a lawyer review the lease before they signed it. The leases are often prepared by the listing broker and negotiated by the parties. In most cases it works out – but standard leases don’t always have the personalized touch that your property needs. This dynamic creates an incentive to ‘close the deal’ and ignore potential pitfalls that could hurt you in the future.
We believe a strong commercial lease agreement can do much more than collect rent:
- Provide protection against unnecessary lawsuits and disputes
- Increase the value of your property
- Reduce disputes between tenants
- Reduce your overhead and expenses
- Preventative clauses can reduce your legal fees
1. Controlling for Assignments and Sublets
Most long term commercial leases do not reach the expiration date, and this is where the language in your contract matters. Most commercial leases prohibit assignments and sublets with out authorization from the landlord. While this is standard practice, every landlord will face requests to terminate early or request to sell a business to a new operator.
A good assignment clause can help you improve your leverage in a potential dispute with the leaving tenant (and the new one as well) – not just grounds for eviction. For example, we protect our clients in tying lease incentives to assignments. If rent incentives are given to tenants (like Tenant Improvements) over the term of the lease, we terminate them once an assignment is signed.
2. Beware of corporate leases provided by national tenants
Most accredited national tenants (like a large pharmacy or fast food chain) will want to use their own lease forms to standardize their operations as a condition to sign. The major issue with that – they are written to protect the tenant only.
Always have an attorney review a lease form provided by the tenant. Always! To name one example, a client came to us after his national tenant stopped a pending sale during escrow after threatening to exercise an option to purchase the property. Unfortunately the owner did not even know the option exited – it was buried deep in the bottom of the lease he signed 7 years ago. The sale never happened and he lost out on a great buyer.
Insurance is the lifeblood of all liability lawsuits. If you own property, someone will at some point will get injured and their lawyer will name everyone in a lawsuit – the tenant and the property owner. Nothing in the lease can prevent this from happening. Instead, we help property owners make sure there is enough of the right coverage in place, by the tenant and the owner, to protect against these kinds of pitfalls.
Certain insurances can also help you recover lost rent and property damage.
4. Reporting and Financials
Adding another task to your yearly checklist might seem like a hassle, but the financial success of your tenants is a major key to your success as a property owner. Successful tenants renew leases, expand operations, and pay rent on time. With this data you can reward successful tenants and phase out struggling ones.
More importantly, this data can make or break a negotiation when it comes time to extend the lease. A tenant with 10% increase in sales year-over-year is much less likely to leave. You can also gauge if the tenant can absorb yearly rent increases.
5. Triple Net/Modified Gross Management
Most commercial leases, especially in strip malls, have some kind of reimbursement of cost in the form of NNN lease. This means tenants pay the landlord’s property taxes, insurance, and common area maintenance in proportional share. A good lease will make sure the collection/reporting of NNN expenses work for the landlord’s system. Things to consider:
- Is your new lease agreement consistent with NNN reporting like other tenants? If all tenants get yearly reports, new lease should be the same.
- Does the tenant has the right to contest the costs? What does the process look like to do so?
- Does the lease have property tax protection in case of a tax reassessment?
These are just some of the issues that can come up. The devil is in the details when it comes to NNN reporting and collection.
6. ADA Compliance
The American Disabilities Act, or ADA, has sprung a whole industry of lawyers who file sham lawsuits to enforce ADA rules, even if the violation is a few inches off. Under the ADA, attorney’s fees can be collected, which could make these lawsuits very lucrative (for the lawyer, that is). If you own a retail center or office building – it is just a matter of time before you will be used by one of these lawyers.
You won’t be able to prevent ADA lawsuits in California. But you can minimize them! With a proper lease, make sure to include ADA compliance to the tenants as well, along with an indemnification provision.
Compliance laws behind signs in almost any city is quite complicated. Cities like Los Angeles have extensive regulation and permit process on which size is allowed on windows, how much it can cover, and issues permits to hang trademarks on pylons signs and above store fronts.
It is important to establish guidelines and responsibility for those signs in case of citations and city violations.
8. Renewals, Options to Extend, and Rent Escalation
Refine your exit strategy for when the lease expires according to your investment strategy. If we have a risk taker client, we draft a flexible renewal provision that asks for market rent with a termination option, in case the market jumps up. For more conservative investors, we have set rent escalations that correlate with inflation.
This is extremely important to strategize ahead of time, before you sign the lease. If you feel that the market is heading up, or want to be prepared for that scenario, make sure you have the opportunity to renegotiate the rent completely, along with other terms in the lease. Clients who want to lock strong tenants down for a possible refinance in 4-5 years might want to stick to scheduled increases and predetermined rent schedule.
9. Who is Guaranteeing the Lease?
Everything is great as long as the rent is paid on the time. But what happens when the tenant defaults? Who do you sue to collect what you are owed? It is crucial to set lease guarantees before you sign it. We assist clients in making sure the signatory (whether it is an individual, LLC, or corporation) is credit-worthy, have assets, and if additional co-signers are needed.
This is often one of the most important parts of a lease agreement. A credit-worthy national tenant can increase the value of your property substantially.
10. Dispute Resolution, Late Fees, and Lawsuits
Most contracts, not just just commercial leases, have some provisions in them that predetermine the rules of engagement between the parties in case of a dispute. Here are a few examples:
- Attorney’s Fees
- Liquidated damages
- Jurisdiction and choice of law
Make sure you tailor your dispute resolution process to your tenant profile, and your investment strategy. For investors who don’t mind risk, we can help curate a commercial lease strategy to match that.
Give us 24 Hours and We’ll Make Your Lease Stronger
It never hurts to have another set of eyes look over a document as important as a commercial lease in California. At worst, we’ll tell you about things you didn’t notice. At best, we can stop problems before they actually happen, increase the value of your property, and make your life easy through the life of the lease.
At Sinai Law, we never over analyze leases and scare clients from getting a deal done. Our team can provide you with a lease report and suggestion for markups within 24 hours of engagement.